Why tax-saving MFs can't be ignored despite their poor returns in recent years

Allirajan M

Equity-linked savings schemes (ELSS), which offer tax deduction for investors and with lower lock-in than several traditional products, have seen lacklustre performance in the last three years.  ELSS continues to be popular among the salaried. Most schemes from this category, which is also known as tax-saver mutual funds (MFs), have underperformed their respective benchmarks during the timeframe.

While tax-saver MFs advanced by a measly 4.2 percent on an average in the last three years, the S&P BSE 500 TRI has gained 5.3 percent. In fact, many funds in the bottom of the performance chart have given negative returns over a three-year timeframe.

Underperformance for quite a while

The three-year CAGR (compounded annual growth rate) rolling return data calculated from the last eight years’ NAV (net asset value) history gives an even bleaker picture. Only a handful of ELSS funds have beaten key benchmarks such as the Nifty-50 and Nifty-100, data from ACEMF showed. The ELSS category has given lower returns than large-cap and multi-cap funds over a three as well as a five-year timeframe, data with Value Research showed.

Industry officials and experts attribute it to the skewed nature of the market rally and the poor show by a significant chunk of mid and large-cap stocks that form a major part of the portfolio of ELSS in the past few years. “Mid-cap stocks have underperformed in the last three years. Even within large-caps, only a select few stocks have done well,” says Kaustubh Belapurkar, director, fund research, Morningstar Investment Adviser India.

“Consumption-oriented stocks outperformed while certain economy-related scrips took a hit in the last couple of years. The divergence in the market rally impacted the performance of ELSS,” says a senior official with a leading fund house. “Several tax-saver MFs invested in economy-oriented stocks. This is because fund managers in ELSS take a long-term view as they do not face redemption pressures like in the case of other equity funds,” he says.

“The large, mid-cap orientation is the reason for the underperformance. In fact, only 7-8 companies have powered the performance of the Sensex pack,” says Suresh Sadagopan, founder, Ladder7 Financial Advisories.

ELSS is considered a stable category in the equities space for fund managers as they come with a lock-in period of three years. This allows flexibility for fund managers in deploying money, as redemptions or investor exits can happen only three years after the investment is made.

Experts believe that the category is still a good bet for wealth creation in the tax-saver space.

Not to be written off

Despite the tepid show in the recent past, ELSS has held up reasonably well over a five-year and seven-year timeframe. While several funds have matched their benchmarks in the last five years, most funds have gained at a quicker pace than key indices over a seven-year timeframe.

“The seven-year performance is still good for most funds. ELSS is a good product for investors as it offers tax savings and is useful in building a corpus,” Belapurkar says.

“Investors should not look at just current returns. ELSS is one of the few products that has a full equity option and has a lower lock-in period to qualify for deductions in in the tax saving space,” Sadagopan says.

Investors can claim tax breaks under Section 80C of the Income Tax Act, which also allows insurance policies, provident fund and public provident fund among others to be counted for tax deductions, with a maximum ceiling of Rs. 1.5 lakh, for their investments in ELSS.

The average returns of ELSS have been higher than inflation in the past. ELSS has also clocked higher returns than its competing products, which invest mostly in fixed income securities, in the tax-savings space.